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Should central banks target inflation, the price level or nominal GDP?The question of the appropriate policy target has been a subject of analysis at least since the 1980s and has become a matter of intense debate (see here and here) for the past several years. Many proponents of price-level or nominal GDP targeting share the idea that – by credibly committing to make up the shortfalls in the price level or in nominal GDP relative to the pre-crisis trend – policymakers could drive down the current real interest rate and accelerate the economic recovery.

Looking at where we are today, what would this mean?

Consider the following two pictures.The top panel is for the price level, measured by the chain-weighted deflator for personal consumption expenditure; the bottom panel is for nominal GDP.In each case, we used the 1990 (third quarter) to 2007 (fourth quarter) business cycle peak-to-peak trend as the baseline (orange line), and then extended that trend forward to 2014.For inflation, the annual trend is 2.1% and for the growth rate of nominal GDP it is 5.1%.

Sources: BEA, FRED, and authors' calculations.

Sources: BEA, FRED, and authors' calculations.

These pictures are striking. First, they reveal that U.S. economic performance prior to the crisis was quite consistent both with a stable price-level target and with a stable nominal-GDP target. Second, it comes as no surprise that the financial crisis changed all of this.Looking at the data through the first quarter of 2014, we see that the price level is now 2.7 percentage points below the 2.1% pre-crisis trend.By contrast, nominal GDP is a whopping 15.6 percentage points below the 5.1% trend.

In practical terms, the top panel means that overshooting a 2% inflation target (or a 2.1% inflation target) to get back to the 1990-2007 price path would be relatively straightforward. It could be achieved by running inflation at 3% temporarily for three years and then returning to the 2.1% path.

The bottom panel shows that getting back to the pre-crisis nominal GDP path is a completely different story. To return to the previous trend within three years, policymakers would need to aim at nominal GDP growth in excess of 10 percent annually. That’s a pace of growth that we haven’t seen since 1984, when the recent era of low inflation began.

The reason for the huge nominal GDP gap is pretty simple:the economy’s trend rate of real growth looks to be substantially lower than it was in the previous two decades. FOMC policymakers have acknowledged this reality gradually by lowering their projections of long-term economic growth from 2.7% as of April 2011 to 2.2% three years later (both estimates are midpoints of the range from the Summary of Economic Projections).

The large gap highlights an important aspect of nominal GDP targeting: when the trend rate of real economic growth rises or falls, the implicit inflation objective also changes (in the opposite direction). The policy question is whether that is desirable. Would the Fed reduce systematic (undiversifiable) risk in the economy by stabilizing nominal GDP if doing so raises uncertainty about future inflation and the price level? Doing so conceivably protects debtors who anticipated a certain level of future income, but it also complicates decisions for households and firms who must distinguish relative price changes from inflation surprises in order to make efficient choices.

All of this leads us to conclude that returning to the price path implied by the pre-crisis trend is a realistic possibility.Returning to the earlier nominal GDP path is not.That said, the inflation overshoot that our rough calculations suggest is moderate, so the benefits are likely to be limited.But the costs could include a loss of credibility in the inflation-targeting framework.Would that really be worth it?